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Algorithmic Trading Sinks American Stock Market

|Includes: Biogen Inc. (BIIB), DIS, SUNEQ

Every country has the stock market it deserves.

Algorithmic trading overwhelms the American market starting in July. Just biotech sector lost its fifth part for three months. Thus, the biotech stock assets of the investors decreased by ~200B.

The shares lose the significant part of their capitalizations without adequate reasons for some weeks or even for some hours. It has become the principal feature of the American stock market in the second part of 2015.

The sufferers of the algorithmic trading

Many favorite and wonderful companies were pushed as Disney (-9% for one day), Biogen (-22% for one day), SunEdison (-25% for one day), Keurig Green Mountain (-30% for one day) etc. Nobody knows why these great companies lost so much. The fund managers use only one explanation and it is the algorithmic trading and its kind - high frequency trading.

I examine Biogen from the list above because the company has a large capitalization and strong business and as very evidential case to show how the algorithmic trading works. Biogen (NASDAQ:BIIB) lost 45% of its capitalization for half year. The maximum day decrease was on July 24, 2015. The share lost 22% for one day with volume 16.6M shares. The usual day volume before this drop was about 1.3M-1.7M shares and then the volume and volatility increased. See please the Chart 1.

Chart 1. BIIB price and volume.

In the day of the 22% decrease the highest trading volume from 16.6M shares showered GS 4.0M shares (21% from total), KCG 2.0M shares (11% from total) and UBS 1.8 M shares (10% from total). Ameritrade sold 2.1M shares in Q3, all other Top-37 holders with quantities of shares from 1M to 11M keep their positions. So it was not total sale, it was just price pushing by tenfold day volume. All names of the participants are known. The records of the transactions exist.

The chart BIIB 1 day price change evidently shows that volatility of the share increased after 22% decrease. See please the Chart 2.

Chart 2. BIIB price, volume and 1 day pct change price.

1 day price change Disney and SunEdison charts demonstrate the same picture. The shares become more volatile.

Chart 3. DIS price, volume and 1 day pct change price.

Chart 4. SUNE price, volume and 1 day pct change price.

Who does need the price volatility? Who is ready to pay for it? See please volume to understand how much. Really option traders need share price volatility. Actually, Biogen and Disney options were widely used for different leverage strategies by investors. The large market capitalizations of the companies were some warrant of the price stability.

It is another one fact confirming option zombie version. Biogen lost more than 6% of its capitalization 3 times for last one and half year, from the time of the previous biotech correction. Firstly, it was on the 21st of March, 2014 as Henry Waxman and his colleagues sent request to Gilead regarding drug prices, then on the 24th of April, 2015, then on the 24th of July, 2015. On the 21st of September BIIB failed with all biotech sector because Hilary Clinton twitter and at the end of August together with all market but the daily decreases were less than 6%. All 3 6%+ decreases were on Friday, at the days of the option executions. Let's estimate the probability that all 3 drops in the days of the monthly (probability 1/22) or weekly (probability 4/22 or 5/22) option executions was a random event. 1/22 x 5/22 x 4/22 = 0.0019, or about 0.2%, 1 chance on 532. Thus, algorithmic trading was used to gain in the option market. The share itself had not value more. It is possible to say that the share was transformed in "option zombie".

VIX chart demonstrates the described phenomena of option zombie for all S&P index.

Chart 5. VIX dynamics.

So it is possible to say that VIX chart is the confirmation of the income repatriation between value investors and algorithmic traders. Autumn anomaly on the VIX chart is a monument of this repatriation.

Q2 BIIB report was great but the share price fail, it is a result of the algorithmic trading

In Q2 the company provided EPS higher then consensus, the sales were less than consensus. How the company could do it? Only by one way, cutting costs. If to see the income sheet for last 5Q

06/2015 03/2015 12/2014 09/2014 Q06/2014

Operating Revenue 2,254 2,224 2,336 2,221 2,118

Selling/General/Admin Expense (492) (560) (574) (570) (577)

Research & Development (491) (461) (500) (417) (447)

Operating Income 1,228 1,110 1,163 1,153 1,001

Diluted EPS from Total Operations 3.93 3.49 3.74 3.62 3.01

it is clear how the company got 2.98% EPS surprise, by decreasing Selling and R&D. As the company sells with discounts in the special health care programs it means firstly decreasing in the line sale because discount and secondly the change in the sale policy and staff respectively. But if to analyze by this way it is necessary to find new reasons for BIIB shares decreasing. For example how to explain the share price 22% decrease for 1 day, on July 24, 2015 if the report was great. Very interesting that analysts did not supposed costs cut initially and did not note later. Nobody studied the influence of the discounting on the revenue.

The role of democrats in the algorithmic trading

Many authors and mass media believe that the twitter of Hilary Clinton was a trigger for biotech market fall in September of 2015. The same opinion was about Henry Waxman and his colleagues' request to Gilead in March of 2014. Both events happened after common market correction. Both events happened in the important for option market days - the day of monthly option expiration, the 21st of March, 2014 and the business day following expiration, the 21st of September, 2015. Another one interesting fact is TOP-5 donors of Hilary Clinton.

1.Citigroup Inc $824,402

2.Goldman Sachs $760,740

3.DLA Piper $700,530

4.JPMorgan Chase & Co $696,456

5.Morgan Stanley $636,564

Source: www.opensecrets.org/politicians/contrib....

4 of them have market interests and volumes in the stock market and in the option market.

Who does pay for the algorithmic trading?

The market pays. Because investors cannot use investment opportunities. The volatility is too high for the investment. Investor hopes usually to receive growth from the business about 5-20%% for the year but now it is like 2-3 or even 1 day share movement. Therefore, in these conditions the investment has not sense. The market become the place just for speculations. Investors leave the market with the algorithmic trading. More than forth of the American investors left the stock market for 10 years. The share of the investors in the USA decreases from 65% in 2007 to 47% in 2015, from two thirds to less than half. I used current cnbc.com information and historical data from gallup.com.

The future of the market with the algorithmic trading

You can see this future on the Chart 6.

Chart 6. RTS and MICEX dynamics.

It is the chart of the market practicing algorithmic trading as the general activity. The equity indexes charts RTS (NYSEARCA:USD) and MICEX (local currency) illustrate it. It is the market practically without local value investor; the local investor involvement is less than 1%. Just local and foreign financial companies bet between themselves on the option prices and push the spot share prices to gain. The multipliers are low; MICEX-10 P/E is 7. Therefore, it is not market for value investor and it is the market without value investor. The USA goes to the same side and goes fast losing about 3% investors every year.

The features of the Algorithmic trading

Is it possible to recognize the algorithmic trading? I am sure that yes. Unfortunately, it will not help to avoid attack on your favorite shares. Firstly because algorithmic trading is like disaster, one minute ago it was not but now it is. Secondly because the algorithmic traders usually choose the favorite assets of the value investors. I constitute a list of the features of the algorithmic trading by empirical way, working, investing and observing different markets for 20+ years.

If you analyze some share and you meet 2-3 features from the list below you can be sure that the algorithmic trading for this share exists. Do not use any kind of leverage for the investment in the share in this case. The good news is that the strong developing company will show an attractive return in the long term and it can take many years. Nevertheless, in the short-term intervals manipulated shares bring a lot of frustration especially for beginners and / or emotional investors.

Features of the price pressure and the presence of active algorithmic trading

1. The positive news does not influence on the share price and negative news influence violently.

2. The share become more volatile. Sharp price movements occur spontaneously and often without reasons.

3. Price movements are significant in the days of the option expirations or following trading day. That is the third Friday of the month and following Monday for monthly contracts, and every Friday and the following Monday for the weekly contracts.

4. Short interest is huge and / or changes sharply for the weeks.

5. There are articles with a clear call to sell the analyzed share, especially if the call is contained in the title of the article. Or/and Media discusses the company's top managers in a disrespectful and mocking manner.

6. The flow of the negative information about the company becomes aggressive and unreasonable. Analytics loses the quality.

7. The share price decreases during the trading day and the respective volume is high. Oppositely, when the share rises for the trading day the respective volume is relatively low. This daily trading volume significantly exceeds the average daily volume in the case of the prices decreasing. This feature itself is clear indication of the price manipulation.

8. The multipliers of the share are significantly lower than the average multipliers of the industry and the multipliers continue to decline.

9. Some authors of the articles argue or simply declare that the using of the company / industry multiples does not make sense and stock prices should follow just by only market participants' sensations without any reference point to multipliers.

10. The share price begins to demonstrate a significant negative correlation with VIX index.

Disclosure: I am/we are long BIIB, DIS, SUNE, REGN, AAPL.